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Krugman on the crisis

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1 December 2008 09:32

 Guest blogger: Peter McCawley is a Visiting Fellow at the Indonesia Project, ANU, and former Dean of the ADB Institute, Tokyo.

Nobel-winning economist Paul Krugman has written a useful summary of developments in the financial crisis for the New York Review of Books. Looking at immediate problems, Krugman highlights the distinction between, first, the need to tackle the credit squeeze choking global financial systems, and second, the broader macroeconomic challenge of propping up overall spending. Krugman argues that governments will need to pump out a lot more money to solve both problems. 

The broad line of Krugman's arguments are supported by many other economic commentators. The policy debate in northern hemisphere countries is therefore focused on two key questions: how much more money is needed, and how should it be spent?

Krugman argues that governments are still being too conservative about spending and must change their thinking. Here in Australia, Federal Treasurer Wayne Swan, who still seems to think that a budget surplus is a good idea, looks like being on the conservative side of the argument. Prime Minister Kevin Rudd seems to be trying to nudge Swan towards the more realistic view that there's nothing wrong with a budget deficit right now.

But much depends on the second issue, which is how additional money should be spent. And that isn't easy. There are all sorts of different views as to how best to throw money at the two related problems of the global credit squeeze and sagging global demand.

In responding to the credit squeeze, American Treasury Secretary Hank Paulson got himself into trouble by initially suggesting that money be used to buy up the 'troubled assets' of banks and other financial institutions. He has subsequently changed track and started giving priority to the recapitalisation of financial institutions. But US policy-makers are still undecided as to how much money they are going to spend on the likes of non-financial corporations such as General Motors.

And there is also much debate on the second issue -- how to prop up sagging global spending. It now seems clear that we are in the early stages of a global recession in northern hemisphere countries. Some observers argue that governments should pump money into infrastructure projects, and the drift of policy in Australia seems to be in that direction. The Centre for Policy Development published a paper by Fred Argy a year ago on Australia's Fiscal Straightjacket, which provides a handy guide to some of the main issues. But other commentators ague that it will take too long to stimulate the economy through support for infrastructure, and that more direct means of stimulating private sector spending are needed.

What about developing countries, especially in our nearby region? Stephen Grenville argues it is in Australia's interests for the Government to help Indonesia respond to the crisis, but that the money would best be spent through regional cooperative mechanisms rather than bilaterally. However, it also needs to be remembered that while short-term measures to help developing countries in Asia are certainly the priority right now, they are not long-term solutions for more abiding regional problems, such as mass poverty.

To tackle mass poverty in Asia, much-improved flows of capital into poor countries will be required. Krugman notes that the financial crisis underlines the obvious urgency of thinking hard about the way financial globalisation has turned into a huge mess. He's certainly right about that. And one of the items on the international financial reform agenda should be the need to provide greatly increased and stable flows of long-term capital to promote development in Asia.

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